This article is from Dollars & Sense: Real World Economics, available at http://www.dollarsandsense.org/archives/2014/0114macewan.html
This article is from the January/February 2014 issue of Dollars & Sense magazine.
at a 30% discount.
The Airfare Mystery
Dear Dr. Dollar:
Boston is 3,280 air miles from London, only 27% further than the 2,580 air miles from Boston to San Diego. So why does a flight from Boston to London cost more than twice as much as a flight from Boston to San Diego, 100% more, for the same dates? Is it just supply and demand?
—Kathleen M. Gillespie, Lexington, Mass.
Airfares do seem to pose a mystery. Supply and demand may help explain things, but these are really little more than categories into which explanations can be placed. If someone says that the flights to London are so expensive because supply is limited relative to demand, we have no real explanation until we explain why supply is limited.
On the surface, the high price of flights on the Boston-London route suggests that this is a very profitable route. So why don’t more airlines fly this route more often, expanding supply, to get a share of the profits?
Beneath the surface (on travel web sites), it turns out that a large part of the price difference between these two routes is not the actual payment to the airline, but taxes and fees. I found one Boston-London-Boston trip for $1,082, where taxes and fees accounted for $656 of that total. On the Boston-San Diego-Boston flight, however, taxes and fees accounted for only $33 out of the $436 cost.
In general, European governments charge much higher taxes and fees than is the case in the United States. From an environmental perspective, the Europeans are probably on the right track, as air travel is an especially polluting (greenhouse gas creating) form of travel. The European governments, however, may simply be motivated by the opportunity to capture revenue.
There are seemingly strange airline fare differences within the United States that are not explained by tax and fee differences. For example, a non-stop round-trip Boston-Detroit flight (630 miles each way) costs about twice as much as a non-stop Boston-Chicago flight (860 miles each way)—$458 compared to $230 for the same times and dates.
This difference is explained by the fact that Delta has a lock on the Boston-Detroit route, while United, American, US Airways, and Jet Blue all fly the Boston-Chicago route. That is, Delta is a monopoly on the Boston-Detroit route and can charge high fares without facing competition. (Northwest used to control this route until it merged into Delta a couple of years ago.)
The Merger that Went Too Far
—Until It Went Through
In an August 16 article entitled For Airlines, It May Be One Merger Too Many, the New York Times reported: “According to the Justice Department, the American-US Airways merger would substantially reduce competition in over 1,000 city pairs served by the two airlines. Among the more egregious examples it cited are Charlotte, N.C.-Dallas; Charlotte-Durango, Colo.; Dallas-Philadelphia; and Kahului, Hawaii-Tampa, Fla. It said the merger would create four out-and-out monopolies, albeit on secondary routes, including three that serve St. Croix in the Virgin Islands. And it said the merger would reduce competition on more than 1,000 routes.”
“It’s pretty clear what happens when concentration increases substantially on a route between two cities. After Continental and United merged, the combined airline accounted for 79 percent of the service between O’Hare International Airport in Chicago and George Bush Intercontinental Airport in Houston. During a three-month period after the merger, fares on that route were 57 percent higher than they were three years earlier, according to the aviation industry Web site PlaneStats.com. United’s fares overall increased 16 percent in the same period.”
The merger of American and US Airways went through on December 9.
Why have no other airlines entered this apparently lucrative Boston-Detroit route? That’s not clear. Perhaps Delta has long-term leases on Detroit airport gates. Or perhaps other airlines, recognizing the economic and population decline of Detroit, believe this market has limited potential. Whatever the reason, it is clear that monopoly control of this route is the issue.
Also, the Boston-Detroit fare portends an ominous future as airline mergers reduce competition further. Following the Delta-Northwest merger, Continental and United came together, and in 2013 American Airlines and US Airways have merged. The American-US Airways merger was originally opposed by the federal government. “According to the Justice Department,” reported the New York Times, the proposed merger “would substantially reduce competition in over 1,000 city pairs served by the two airlines” (see box). However, after some relatively minor concessions by the airlines—giving up some of their gates at major hubs—the Justice Deparment withdrew is objection and the merger went ahead.
While monopolistic situations and taxes and fees explain some of the “mystery” of airline fares, there is more. Flights and times that are heavily used by business travelers tend to have high fares because business travelers are less concerned about the price. This is partly because they often have limited flexibility, but also because airfares are deductible as a cost of business—i.e., the taxpayers pick up part of the tab.
Also, the price for a particular flight can change dramatically within a day or even within hours. When I was trying to book a flight one evening, the cheapest ticket I could find was about $600, but by the next morning I got the ticket for about $300. I suspect that in this case the airline (using computer-based forecasting) recognized that the flight was not filling and therefore reduced the price to attract more customers.
And things can work in the other direction. Making a reservation at the last minute, the potential passenger is often faced with a very high fare because the airline views the traveler as having little flexibility. For example, if I make a reservation to fly Boston-Chicago-Boston, leaving tomorrow and returning two days later, the fare would be over $900, as compared to the $230 I would pay if I made the reservation a few weeks in advance.
So, yes, supply and demand can help explain the variation in airfares. But to really understand what is going on we need to know a good deal more.